Posted on: May 21st, 2020
The mezzanine debt market is a large ecosystem with over 1,000 funds in the U.S alone. These funds come in four major forms – Small Business Investment Corporations, Private debt funds, Business development corporations and Finance companies. These lenders provide a variety of loan structures all based on mezzanine debt cash flow lending fundamentals wherein debt capacity is determined by a multiple of EBITDA. Some lenders focus on private equity sponsored deals while others focus on non-sponsored or independent sponsored deals. Some lenders focus on lower middle market while others focus on upper middle market sized deals.
A company sourcing a mezzanine debt like loan structure has a strategic funding need for capital to do something important. That something is usually a growth step or transition that provides significant scale-up possibility for the business such as an acquisition or new product launch. Given the large size of the funding required relative to the cash flow of the business, there is a need to tap a more aggressive loan structure to bring in the right amount of capital needed. This lender is called to provide a capital solution that will extend the growth runway of the business, so the company can confidently execute its strategic growth plan. This execution period involves a lot of risk as the company is usually integrating a newly acquired business or cultivating new marketing channel.
Teaming with a lender that can provide a mezzanine debt like structure helps the company mitigate capital stability risk during this period in a few important ways. The mezzanine debt like structure provides a longer term and requires virtually no principal repayment during the term. It also is flexible as to how the proceeds of the loan are used and does not require a personal guarantee. It is a form of patient long term capital that allows your company to safely transit through its growth journey.
The key is to select the right lender, as picking the wrong lender can be a disaster. The right mezzanine debt lender is a great partner to have and they will provide a continual stream of capital to the company, if needed. The wrong one will consume a lot of your time and cause a lot of headaches and put your business at risk. The key is knowing how to screen these lenders and making sure you are getting a legitimate, time tested, high character lender.
Here are the Attract Capital 4 steps to take to select the right mezzanine debt lender.
1.Avoid untransparent funds- these funds talk a good game but often cannot deliver. That is because they do not have their own money and must go to another fund to get it. They are more like an intermediary than they are a lender but pass themselves off as a lender.
2.Avoid inexperienced funds- funds comprised of recent graduates or non-industry folks often cannot get a deal done or be a reliable partner. Experience is the best teacher in the mezzanine debt market so try to fund a fund that has a few folks that are long in the tooth or have grey hair.
3.Avoid funds with problems in the portfolio- problem credits in the portfolio can change the behavior of the fund. When a lender misses a big issue and is staring at a big write off, it is hard for them not to be overly skeptical to all companies in the portfolio.
4.Avoid funds that have too many cooks in the approval kitchen – Many funds like to have companies run the approval gauntlet. This can mean the company meeting with 10+ people from the lender with no ground rules or agenda for questions. This approach is absurd and usually results in a bad meeting and ill will on the part of the company. Make sure the lender you are working with has an organized, streamlined approval process. The process should be transparent, and you should know who the decision makers are upfront.